As we enter 1992, the recovery appears extremely vulnerable. It will be sustained, however, by the lowest short-term interest rates in the past two decades, an accommodative Federal Reserve, and a government commitment to put the economy back on track.

Contrary to the dismal forecasts from the doomsayers, the economy will emerge from recession. The apparent sudden sinking of the economy in the fourth quarter of 1991 has blinded many to the favorable factors supporting an economic recovery. The economy is in the final stages of its contraction and seeds for revival have already been sown. The unprecedented decline in consumer attitudes which have prevailed for too long will slowly reverse themselves as the scars of the 1980s heal and fragile consumer and business balance sheets improve.

Excessive spending and debt in the 1980s, which ushered in a falling savings rate, will be replaced by more sober attitudes which are already evolving and which will provide the foundation for a sustainable long-run recovery. The savings rate, which had fallen to 4.3 percent in 1987, and remained at that low level throughout the late 1980s, recovered in 1990 to 5.1 percent, and has remained firmly in a 5.0 percent to 5.5 percent range so far in 1991. Higher savings will be the backbone of a revived consumer in the coming years.

All of the fundamental indicators point to a slow growth recovery in 1992. The strongest rate of growth will emerge in the second half of the year. Growth should improve progressively from a low of only about 0.4 percent in the first quarter to a high of 4.0 percent in the third quarter. For the 1992 year, economic growth will average about 2.5 percent. While this low rate of growth may at first seem disappointing, it is characteristic of the trend rate of economic growth that should prevail during the next three to five years.

Salomon Brothers

Robert S. Salomon Jr.,

head of research

Dec. 23, 1991

Our 1992 projection for the Dow Jones Industrials is 3,300-3,400.

The economic recovery will be slow but sustainable. We estimate real growth at 1 percent in the final quarter of this year, 2 percent in 1992 and about 2.5 percent in 1993. Inflation will remain moderate. This environment is positive for equity valuation levels and partially explains why stocks have held ground reasonably well in the face of considerable uncertainty. A lack of alternative investments is another part of the explanation. Rates on U.S. Treasury bills are now at levels last seen in 1973. Investors that have grown comfortable living without risk now find that they cannot live on the returns from their cash. In addition, real estate does not provide much competition.

With an election year approaching and a weak economy, the Fed is likely to remain under pressure to ease monetary policy, bringing interest rates even lower and further enhancing the attractiveness of equities. In this environment, we emphasize interest-rate-sensitive issues in the financial sector and stable-growth stocks in the consumer area. Our approach to cyclical issues has grown more selective with the weakening economy: We recommend that exposure be limited to early-cycle plays, extremely undervalued stocks or companies that can show strong earnings gains even if top-line growth is modest.

Based on the post-war experience, earnings in the earliest part of an economic recovery are the most volatile and, hence, the most difficult to predict. S&P 500 operating profits for the 12 months following a trough in the economy have risen by 13 percent on average, but the range extends from gains of 2.5 percent (off the 1974 trough) to 23 percent (off the 1954 trough).

Conceptually, earnings in the first year of a recovery should grow more quickly than in subsequent years, because costs are low and inventories are lean. In four of the six postwar cycles, however, profits have grown either at the same rate or faster in the second "year" (measured by quarters from the trough). Here, the average growth rate is 9 percent, ranging from a decline of 14 percent in 1951 to a gain of 18 percent in 1984. Excluding 1951, the average rate of gain in the second year is 14 percent.

A slow but steady pace of economic expansion is not the stuff of which explosive profit growth is made. Such an environment, however, should provide incentive for companies to keep costs low. Thus, we expect S&P 500 profits in 1993 to be about $27.00 per share -- up by 8 percent from our estimate of 1992 earnings.

Donaldson, Lufkin & Jenrette

Eric Miller, senior vice president, research department

Dec. 31, 1991

We had suggested a modest lowering of equity exposure last September in preparation for what we had expected would be a disappointing stretch of economic and earnings news. On weakness [in stock prices] we had expected to urge more fully invested positions.